Fridays Academy: Economic Growth and Poverty

From Raj Nallari and Breda Griffith's lecture notes. This and upcoming Fridays we will analyze the interrelationships between economic growth, poverty and inequality. In recent years there has been a lot of discussion on pro-poor growth, which is essentially an attempt to examine the degree to which economic growth benefits the poor. This topic will also be examined.

Economic Growth and Poverty Reduction

Sustained economic growth has a positive impact on poverty reduction. The literature is firm on this point. Numerous cross country studies indicate that the main determinant of poverty reduction is the pace of economic growth.

The evidence

Kraay (2004) finds that approximately “half of the variation in short-run changes in poverty can be explained by growth in average incomes. In the medium to long run, between 66 and 90 percent of the variation in changes in poverty can be accounted for by the growth in average incomes.” The recent report from the Operationalizing Pro-Poor Growth research program showed that in those countries (11 of the 14 studied) that experienced economic growth, a 1 percent increase in GDP per capita reduced poverty by 1.7 percent during the study period (1990 to 2003). For some countries, such as Vietnam, the reduction in poverty was spectacular – a halving of the poverty rate from 58 percent to 29 percent (or almost 8 percent a year). Furthermore, poverty declined by rates of between 3 and 6 percent per year in El Salvador, Uganda, Ghana, India and Tunisia.

Consistent with the positive relationship between growth and poverty reduction, it has also been found that incomes of the poor appear to rise proportionately with average incomes (Dollar and Kraay, 2001). Plotting per capita incomes of the poor against average per capita income for 137 countries they find a strong, positive linear relationship between the two variables (with a slope of 1.07). Moreover, plotting the annual average growth in incomes of the poor against average annual growth in average incomes for 92 countries also yields a strong positive, linear relationship between the variables (with a slope of 1.19). Other researchers have also found that poverty trends tracked growth trends very closely in the 1980s and 1990s. For example, according to Chen and Ravallion (2000), on average, growth in the consumption of poorest fifth of the population tracked economic growth one-for-one over this period.

Source: Dollar and Kraay (2001)

Unsurprisingly, the converse also holds: low or declining economic growth leads to increases in the incidence of poverty. Thus, in the vast majority of countries studied by Chen and Ravallion (ibid.) growth led to rising consumption in the poorest fifth of the population, they also found that economic decline led to falling consumption. In a more recent study, Lopez (2005) found that economic decline in per capita income in Argentina (1993 to 2002) and Zambia (1991 to 1998) led to increases in the incidence of poverty. Similarly, three of the countries – Zambia, Indonesia and Romania – in the Operationalizing Pro-Poor Growth study that exhibited little or no economic growth over the study period (1990 to 2003) experienced increases in poverty.

Country examples of the link between economic growth and poverty

Few economists doubt that economic growth is necessary for the long-term reduction of poverty. But how close is the link between the two? Dollar and Kraay (ibid.) gathered information on the per capita income of the poor (the bottom quintile of the income distribution) and on overall per capita income. The data come from 80 countries over four decades, and Dollar and Kraay were able to piece together 236 "episodes," - periods during which it was possible to measure changes in the income of the poor and of the country overall. The main conclusions of this study have been that:

The per capita income of the poorest quintile grew in line with overall per capita GDP for the 80 countries in the same over the four decades covered. In short, growth matters and the poor are not generally left behind in the process.

The relationship in equation has not changed over time, and applies both in rich and poor countries. In short, growth still matters.

The incomes of the poor do not fall disproportionately during an economic crisis.

Greater economic openness, the rule of law, fiscal discipline, and low inflation all contribute to (or are at least associated with) faster economic growth, and in this manner help the poor.

Democracy, and higher public spending on health and education, does not have a measurable effect, one way or another, on the incomes of the poor.

The relationship between economic growth and poverty reduction appears to hold for both absolute and relative measures of poverty (Lopez, 2004). The former is defined as an income level below a pre-specified threshold, e.g. PPP adjusted US$1 per person per day, or a country-specific poverty line based on subsistence needs, while the latter is defined as a pre-specified proportion of the population, usually the lowest quintile of the population.

Growth derives from economic inputs – capital and labor – and how efficiently these inputs are used. Because simply adding inputs typically becomes less effective in terms of generating growth over time – referred to as diminishing marginal returns in the literature – sustaining good growth performance typically requires making factors more productive. This can be achieved in turn, through, for example technological advances, improved management know-how and/or skills acquired through education. Viewed through this prism, the robust growth experience of Uganda (more than 6 percent a year on average since the mid-1980s) and the consequent success in lowering poverty is not as impressive as commonly thought. Specifically, Pattillo, Gupta and Carey (2005) find that Uganda’s growth achievements were predominantly due to capital accumulation (investment) and very little to do with productivity gains. As noted by the authors ‘because increasingly higher investment rates (and consequently, rising national or external saving) are not feasible, low TFP growth seriously threatens Uganda’s achievement of sustained high growth and poverty reduction’.

Comments

Thank you very much for sharing great knowledge with us.
I really enjoy your blog in Japan and am looking forward to seeing yours every Friday.
To deepen my understanding, Iâd like to access to the references which are listed in your blog.
Could you show us a reference list?

Dear Takemoto. Thank you for your kind message. We are glad to see that we are read in Japan and that you find our Fridays Academy series interesting.

The reference list is very extensive and I can’t post an attachment here in this comment. I will be happy to send it to you by email. You can reach me at ihernandez [@] worldbank.org (without the brackets).

Hi,
I'm writing from Canberra Australia. I'm confused; is this article suggesting that economic growth, as a means of reducing poverty, should take precedence over universal rights? Also, whilst these figures speak volumes as to the relationship between econmic (pro-poor growth) and poverty reduction, it fails to account for the typical means of such growth, i.e. I believe that this growth has historically been stimulated through unsustainable production of natural resources, and moreover, that the imagined community does not benefit through "making factors more productive..." (well im studying anthropolgy so excuse my naivity). What am I failing to see?

2005. “Pro Growth, Pro Poor: Is There a Trade Off?” Prepared aspart of the Operationalizing Pro-Poor Growth research program. Policy Research Working Paper 3378. World Bank, Washington, DC.———. 2005a. “Growth and Inequality: Are They Connected?” Prepared as part of the Operationalizing Pro-Poor Growth research program. Processed.World Bank, Washington, DC.———. 2005b. “Pro-poor growth: How Important Is Macroeconomic Stability?”Prepared as part of the Operationalizing Pro-Poor Growth research program. Processed. World Bank, Washington, DC.